Cyprus Mail

Economist proposes reducing deposit tax to counter likely ECB rate hike

The government may have to consider reducing the currently 30 per cent tax rate on income from deposits in order to help banks cope with a likely reversing of the European Central Bank’s (ECB) accommodating monetary policy, an economist said.

His proposal is likely to steer controversy as a colleague of his expressed reservations both with respect to its effects and effectiveness.

“An interest rate hike by the European Central Bank (ECB) could be a negative development for the Cypriot economy but banks could then resort to further squeezing deposit rates and so avoid increasing lending rates,” independent economist Stavros Agrotis said in a telephone interview on Wednesday. “Should the government reduce the tax, depositors may be willing to accept a lower rate”.

Agrotis, a former banker at Bank of Cyprus, said that banks are currently engaged in a “balancing act” trying on the one hand to reduce on the one hand their non-performing loans which account for roughly half of their loan portfolio, and on the other maintain their profitability amid increased competition which puts pressure on their net interest income.

The ECB has a mandate of maintaining price stability by targeting an inflation rate of “close to but below 2 per cent” in the medium term. A further pickup of the inflation rate in the euro area which over the past year remained below the 2 per cent mark, may prompt the ECB to reverse its monetary policy of countering the risk of deflation, which prompted an expanded asset purchase programme in 2015 and negative interest rates.

Agrotis also said that putting pressure on the net interest income also “has its limits” as banks also need to cover their expenses with both households and companies being over-indebted. Banks already agree to a reduction of lending rates as part of loan restructuring agreements, he added.

The Central Bank of Cyprus said on Wednesday that the net interest income of Cypriot banks fell to 2.2 per cent as a percentage of assets in the first quarter from 2.5 per cent the quarter before and 2.7 per cent in the first three-month period of 2016. The drop was partly on an increase in interest expenses to 1.4 per cent in the first quarter from 1.3 per cent in the last quarter of 2016.

Deposit and lending rates stand today at a historic low partly on the ECB’s low interest rate policy and partly the Central Bank of Cyprus’s decision to relaxing regulatory requirements in early 2015 to help Cypriot lenders reduce rates.

According to the Central Bank of Cyprus, depositors received on average 1.37 per cent on new deposits with up to a 12-month maturity in May, which is close February’s all-time low of 1.32 per cent. Households were charged on average 3.25 per cent for their mortgages and companies with 4.06 per cent for loans below €1m which is again in both cases close to historic lows. Still, deposit rates are likely to further drop even in the absence of any government intervention.

Last week, Bank of Cyprus, the island’s largest lender which in January announced the fully repayment of its once €11.4bn emergency liquidity to the central bank almost four years after converting half of its uninsured deposits to equity as part of Cyprus’s bailout agreement, informed its customers of its decision to further reduce deposit rates as of August 1, 2017.

Economist Marios Clerides, also a former banker said, that scrapping or reducing the tax on interest income “could potentially upset the balance of taxing income”.

In addition, Cypriot banks factor in the ECB’s or Euribor rates in the pricing formulae and any changes in rates would be automatically transmitted to the customer, he said.

Therefore, Clerides advised banks to factor in when extending new lending or agree to loan restructurings, a probable increase of the ECB’s monetary policy which would affect the ability of borrowers to service their loans.

Whether the government which initiated in 2015 a series of tax breaks in an attempt to revive the real estate market is also considering reducing the tax on deposits increased prior to the signing of the 2013 bailout agreement, remains unknown. A finance ministry spokesman said that he was not aware whether any such plan existed.

Should the government heed the reservations of Clerides and reject the idea of reducing the taxation on deposits, households may still resort to reducing consumption -which last year rose 2.9 per cent- in order to meet their obligations to the bank, Agrotis said.

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